YIELD OF DREAMS: Are Investors Starting to Wake Up and Smell the Rally?

For months, we’ve been scratching our heads over why retail investors have been fleeing U.S. equity mutual funds and flocking to bond funds and U.S. Treasuries, where yields are practically non-existent. (It’s provided even more proof that investors buy high and sell low.) But recent mutual fund flow data shows that the trend might be reversing, or at least that investors are wising up for the time being.

For months, we’ve been scratching our heads over why retail investors have been fleeing U.S. equity mutual funds and flocking to bond funds and U.S. Treasuries, where yields are practically non-existent. (It’s provided even more proof that investors buy high and sell low.) But recent mutual fund flow data shows that the trend might be reversing, or at least that investors are wising up for the time being.

U.S. equity mutual funds saw two straight months of inflows, taking in $5 billion in January and February, according to Strategic Insight data. Granted, February’s inflows were led by equity income funds at $3 billion, but in total, equity mutual funds raked in about $10 billion in net new money. ETF flows are also off to a good start.

Are investors finally starting to wake up and smell the rally? Year to date, the S&P 500’s up 9.02 percent. SI’s Director of Research Avi Nachmany says:

Memories of extreme volatility are fading, albeit very slowly, as US mutual fund investors are tiptoeing back into riskier assets. That’s why we have seen more fund shareholders choose to participate in financial markets via bond funds. Many uncertainties continue to hover over the markets, including the Eurozone situation and the sustainability of US job growth. Nevertheless, while caution remains the overarching mood, encouraging flows trends to stock funds are evidenced, and such may accelerate in the coming months.

Of course, it’s not a huge trend into equity mutual funds; investors are just warming up to the idea. After all, bond funds still lead the flows, drawing $35.9 billion last month.

For all open-end mutual funds, February had the highest monthly net inflows since March 2010, with $46 billion in positive flows, Strategic Insight said.

Two months don’t make a trend, but perhaps 2012 will be the year retail investors finally get off the sidelines and start putting money into equity funds.